What is a Conservative Investment Portfolio?
Investing seems like an inherently risky affair for many people but it’s not true at all, you can actually choose what level of risk you’re comfortable with. Why would you choose a higher risk? There can be only one good reason: it should give you a higher return on investment. People are different and their goals are different so some people are willing to sacrifice some of the expected return in order to lower their risk and that’s what people mean when they say that some investor or a portfolio is ‘conservative’.
Who Should Consider a Conservative Approach?
Conservative investment strategies are ideal for people with low-risk tolerance, which means that they’re not willing to risk their money in order to achieve a higher potential return. People that are close to retirement, as well as anyone else who might need to sell their assets shortly, in order to spend their money on something else, might prefer to have a conservative investment portfolio because it gives them the flexibility of being able to withdraw their money at any moment.
Younger people could be better off with a different investment strategy.
That leads us to the most common definition of risk in finance: having a risky portfolio doesn’t always mean that you have a high probability of losing your money, it just means that you might have to wait for a long time in order to be able to liquidate your position without suffering significant losses and, as a reward for your patience, you can expect a better return on the long run.
What Are The Most Common Conservative Assets?
Now we know who might prefer a conservative portfolio, it’s time to take a look at the conservative assets that could fit such a portfolio:
- Blue chips – stocks with a long and stable history, such as Coca-Cola, McDonald’s and so on. You’ll also get some dividends from those stocks
- Fixed income bonds (Treasury Bonds, Corporate Bonds, etc.)
- Savings bank accounts and deposits
- Retirement accounts
- Conservative exchange-traded funds (ETF) and mutual funds
- Real estate (although its value for a conservative portfolio is arguable)
Some of those options are more risky than others so you have to look at each option carefully.
It might be beneficial to seek a professional advice from a portfolio manager or a financial advisor.
What is The Main Goal of a Conservative Strategy?
The main goal of a conservative investor is to have a capital gain or income above the current level of inflation. Let’s say that the annual inflation in the United States is 2% per year and, with a conservative approach in mind, you may allocate your money in a bank’s saving account which promises you 2-2.5% a year in interest payments.
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Of course, you won’t earn a lot with such a strategy, but you can be quite certain that you won’t lose your money (money value, to be precise) due to the inflation or any other unfortunate event. It’s important to understand that not investing your money can be more risky than investing it because you can’t protect your money from the disastrous effects of inflation unless you invest it.
When to Use a Conservative Strategy?
In certain cases, keeping a conservative investment portfolio might be your best option.
One of those cases is when you don’t have a lot of experience in finance, maybe you are just starting to save money and have a limited capital. In this case, it might be wise to build a safe portfolio right now and later, maybe, you can improve it by adding some risky assets.
Another good case for a conservative strategy is when you have a good knowledge of the current market situation and you don’t like what you see. You might decide to move to safe assets and wait until the market take a nosedive, so you’d be able to come back later to buy the dip. It can be said that with such a strategy you are ‘parking’ your money.
Let’s imagine that you just sold your house. Obviously, you don’t want to go to a casino and bet everything on red in this case, but you don’t want to keep your cash under the bed as well, so you might go with a low risk / low return investment strategy.
Mixed Strategies and Diversification
A common strategy is to mix regular medium-risk investments with something stable and conservative in a certain proportion. You can have 25% of your total capital allocated in the moderate-risk assets such as stocks, and to keep the rest of your portfolio in the less risky assets such as bonds. This is generally a smart thing to do, even professional investors and huge funds do that quite often. In fact, if you break down almost any major fund or a big company, you’ll see how they allocate a large portion of their portfolio to some very simple and boring low-income investments. That is how they hedge their risk with diversification, and so might you.
You can decide how conservative you want to be and what portion in your portfolio should be allocated to low risk (and low income) assets. If you don’t have time to track certain stocks trying to figure out which ones are going to grow soon, you may just choose a stable low yield tool like a bond instead.
Another good option would be to add a more risky, but potentially more profitable asset to your conservative portfolio. Buy a stock index ETF that can give you more income or something like that with a higher risk to have a possibility to overperform fully conservative portfolio.
There are two main ways of getting money from your investment:
- Capital gain (when something grows in value)
- Current income (interest on bank’s account, dividends, business income, rent from property, etc.)
If a price of a certain stock rises from $10 to $20 and you have 100 shares, your capital gains would be $1000 for this period of time. It’s quite easy to calculate and most investors are trying to maximize their capital gain instead of their current income.
Current income is a more passive and somewhat lazy type of income, yet it can be even more profitable in a long-term perspective.
People tend to overlook current income investments due to many reasons, one of which is that it’s generally a pretty low income. Companies don’t usually pay high dividends to their shareholders and, as you might know, the banks are doing everything in their power to reduce the interest they have to pay you.
That being said, there are some interesting current income investments to consider but this isn’t an easy subject, especially if you’re looking for something with the income above the market average.
The best example of a current income investment is when you have your own business and you know that with X additional capital this business would expand and generate Y in additional profit each month, and, as a sole owner, you would get most of it.
Unfortunately, those investments require a lot of money and not everyone has a business.
Current income is helpful for people who want to see regular cash flow from their investments rather than just to see it grow in value which can be converted to real money only when you sell a portion of your portfolio. By receiving a monthly income in a form of dividends or interest, you have an option to re-invest it and expand your portfolio, or you can just use it and spend it, this is up to you.
How Much Money Do I Need to Create a Conservative Portfolio?
Technically, you can create any portfolio with just $100, but if it’s an active stock portfolio, you might have certain issues such as transaction fees and inability to diversify your portfolio because the shares of some companies can be pretty expensive. It’s usually much easier to create a conservative investment portfolio if you don’t have a lot of money for investment purposes. Don’t forget that you can always make your portfolio more “aggressive” in the future when you would feel that it might be appropriate.
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